ECB supervision defends capital standards as it streamlines bank oversight

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Highlights

The ECB Supervisory Arm is streamlining bank oversight by removing outdated guidelines and focusing supervisory reviews on risk-based, bank-specific capital requirements without weakening prudential standards.
Supervisors are increasing scrutiny on banks' direct and indirect exposures to geopolitical risks, commercial real estate, and SME segments, urging more forward-looking risk modeling amid rising interest rates and persistent sector vulnerabilities.
The ECB highlights growing industry risks from shadow banking and reliance on non-EU cloud providers, while advocating for harmonised EU-wide rules, a common deposit insurance scheme, and the implementation of the digital euro to boost financial stability and operational resilience.

Supervisory overhaul keeps prudential focus

As reported by ECB Banking Supervision, citing the ECB Supervisory Arm, Supervisory Board member Sharon Donnery says the central bank's next-level supervision initiative is intended to make oversight more effective, efficient and risk-based without weakening prudential standards. She says the ECB has reviewed more than 100 supervisory publications, removed outdated documents and simplified guidance so banks can navigate supervisory expectations more easily.

Donnery says strong capital is a precondition for competitiveness rather than a constraint on growth, and that capital and other requirements remain anchored in underlying risk profiles. In the reform of the Supervisory Review and Evaluation Process, she says supervisory attention is shifting more toward the risks that matter most for each institution, while Pillar 2 requirements continue to reflect bank-specific risks not sufficiently covered by Pillar 1.

She also says geopolitical risk is now a structural feature of banks' operating environment, with supervisors seeing weaknesses in how lenders capture indirect exposures through customers, supply chains and markets. Banks are expected to supplement historical models with forward-looking scenario analysis and embed those risks in their risk appetite frameworks.

On asset quality, Donnery says the sector enters the current period of higher interest rates from a position of strength, with non-performing loan ratios well below post-crisis levels. She adds that commercial real estate and some small and medium-sized enterprise segments still warrant close attention because refinancing pressure, valuation adjustments and weaker growth can hurt repayment capacity.

Industry risks widen from shadow banking to digital infrastructure

Donnery says the expansion of non-bank finance is increasing interconnectedness with the banking sector through credit exposures, liquidity facilities, securities financing, derivatives, margin calls and shared asset holdings. In that setting, she says supervisors want banks to improve their understanding of contagion channels, concentration risks, collateral quality and liquidity demands as vulnerabilities outside the banking system can spread quickly in periods of stress.

She says operational resilience is also becoming a system-wide issue as banks rely more heavily on a small number of cloud providers outside the European Union. Where concentration risk is significant, banks are expected to map critical functions and cloud services, strengthen senior management oversight, prepare exit strategies and run regular business continuity tests.

Donnery says weaknesses in risk data aggregation and reporting remain among the most persistent problems across European banking, reflecting not only technical shortcomings but also governance and accountability issues. On market integration, she argues that completing the banking union with harmonised rules, a common deposit insurance scheme and a stronger crisis-management framework would help reduce national ring-fencing and allow capital and liquidity to move more efficiently across the system.

She also says the digital euro should function as a means of payment rather than a store of value so that financial stability and bank intermediation are protected. While implementation costs are significant, she says the project could give banks opportunities to build new payment services, deepen customer relationships and support a more autonomous European payments ecosystem.

Our earlier article on the EU’s proposed expansion of ESMA’s supervisory powers explained how Brussels wants more centralised oversight of large cross-border exchanges, market infrastructure and crypto firms to reduce fragmentation in capital markets. It also highlighted pushback from some member states seeking exemptions for major national operators, warning that carve-outs could dilute the Commission’s plan and weaken the drive for more efficient cross-border markets.

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